Homeowners association loses social-welfare exemption

Plain-English summary

A homeowners association restricted membership to subdivision lot owners and used member assessments to maintain a lake, beaches, parks, and a tennis court, as well as limited member social activities. The common areas were reserved exclusively for members and bona fide guests, with signs prohibiting public access. The IRS concluded that the association operated for its members' private benefit rather than for the common good and general welfare of the community. Because a section 501(c)(4) homeowners association's common facilities must be available for public use, the IRS revoked the exemption effective at the beginning of the examined year. The association consented to the proposed action and was required to file federal income tax returns.

Ruling snapshot

• Question: Does a homeowners association whose common areas and activities are restricted to members and guests continue to qualify under section 501(c)(4)?
• Outcome: Revocation; the association's exemption was revoked effective January 1 of the examined year.
• Key authorities: IRC § 501(c)(4); Treas. Reg. § 1.501(c)(4)-1(a)(2)(i); Rev. Rul. 74-17; Rev. Rul. 74-99; Commissioner v. Lake Forest, Inc., 305 F.2d 814 (1962)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Tax Exempt and Government Entities Division

Exempt Organizations: Examinations

1100 commerce Street

Dallas, TX 75242

Date: October 5, 2015

Number: 201604019 Taxpayer Identification Number:

Release Date: 1/22/2016
Form:

Filing Period(s) Ended:
Person to Contact/ID Number:

UIL: 501.04-07
Contact Numbers:
Phone:
Fax:

CERTIFIED MAIL - RETURN RECEIPT REQUESTED

Dear                  :

In a determination letter dated January 31, 19XX, you were held to be exempt from
Federal income tax under section 501(c)(4) of the Internal Revenue Code (the Code).

Based on recent information received, we have determined you have not operated in
accordance with the provisions of section 501(c)(4) of the Code. Accordingly, your
exemption from Federal income tax is revoked effective January 1, 20XX. This is a final
letter with regard to your exempt status.

We previously provided you a report of examination explaining why we believe
revocation of your exempt status was necessary. At that time, we informed you of your
right to contact the Taxpayer Advocate, as well as your appeal rights. On August 10,
20XX you signed Form 6018-A, Consent to Proposed Action, agreeing to the revocation
of your exempt status under section 501(c)(4) of the Code.

You are required to file Federal income tax returns for the tax period(s) shown above. If
you have not yet filed these returns, please file them with the Ogden Service Center
within 60 days from the date of this letter, unless a request for an extension of time is
granted. File returns for later tax years with the appropriate service center indicated in
the instructions for those returns.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate
assistance is not a substitute for established IRS procedures, such as the formal
appeals process. The Taxpayer Advocate cannot reverse a legally correct tax
determination, or extend the time fixed by law that you have to file a petition in a
United States court. The Taxpayer Advocate can, however, see that a tax matter that


may not have been resolved through normal channels gets prompt and proper
handling. You may call toll-free, 1-877-777-4778, and ask for Taxpayer Advocate
Assistance. If you prefer, you may contact your local Taxpayer Advocate at:

Internal Revenue Service
Taxpayer Advocate Service

If you have any questions, please contact the person whose name and telephone
number are shown at the beginning of this letter.

Thank you for your cooperation.

Sincerely,

John A. Koskinen
Commissioner

By
Margaret Von Linen
Director, EO Examinations


Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit

Explanation of Items

Name of Taxpayer Year/Period Ended

December 31, 20XX

Initial Examination Report

We conducted an examination of your Form 990 and related books and records for
tax year ended December 31, 20XX. The following represents our initial exam report
for purposes of conveying our initial findings and proposed changes to your exempt
Status, as a result of the examination process.

Facts:

You are an association of homeowners owning residential lots in the
Subdivisions numbers 1-4 and surrounding the                  .

On October 10, 19XX, you submitted a Form 1024, Exemption Application” to Internal
Revenue Service seeking recognition as tax exempt entity. Based on the information
presented in your application, you were granted a favorable ruling as a social welfare
organization described in Section 501(c)(4) of the Internal Revenue Code (IRC).

On December 10, 19XX, you were organized as an incorporated homeowner's association
by filing Non-Profit Articles of Incorporation with the State of                  .

In the most recent version of your By-laws, adopted January 15, 19XX, the purpose(s) of
your organization, as stated in Article 3, is provided as follows:

A. “Whereas, the Association desires to provide for the preservation and enhancement
of the property values and amenities in the Subdivision known as
nos.1 through 4, which surrounds the area known as                  and for the
maintenance of certain Common Areas (as defined below) and to this end desires to
subject the Subdivision and the Common Areas to the easements, covenants,
restrictions, charges and liens set forth herein, each and all of which is and are for
the benefit of the Subdivision and each owner therein”.

B. “Whereas, the Association has deemed it desirable for the efficient preservation of
the values and amenities in the Subdivision to maintain and administer the Common
Areas; to collect and disburse the assessments and charges hereinafter created;
and to promote the recreation, health, safety, welfare, common benefit and
enjoyment of the Owners”.

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service

Page: -1-


Form 886A

Department of the Treasury - Internal Revenue Service

Explanation of Items

Schedule No. or Exhibit

Name of Taxpayer

Initial Examination Report

Year/Period Ended

December 31, 20XX

Eligibility for membership in your organization is restricted to only the lot owners owning
real estate within the subdivision.

You are funded exclusively through the collection of annual assessments from your
members. Your expenditures are disbursed exclusively for the purpose of maintaining
common areas, administrative costs, and conducting limited social activities (annual picnic,
ice cream socials, etc.). Participation in your social activities is restricted to members and
guests only.

The common areas owned and maintained by the organization are comprised of a lake, 2
beaches, 3 parks, and a tennis court. The maintenance, use, and enjoyment of these
common areas are provided for the exclusive benefit of the organization’s members and
bona fide guests. Any access or use by the general public is strictly prohibited and signs
have been erected at entry points to warn non-members of this prohibited use.

Applicable Law:

IRC Section 501(c)(4) provides for exemption from Federal income tax of civic leagues or
organizations not organized for profit, but operated exclusively for the promotion of social
welfare.

Tax Regulation Section 1.501(c)(4)-1(a)(2)(i) provides that an organization is operated
exclusively for the promotion of social welfare if it is primarily engaged in promoting in
some way the common good and general welfare of the community, i.e., for the purposes
of bringing about civic betterment and social improvements.

In Revenue Ruling 74-17,1974-1 CB 130, (Jan. 01,1974), the Service held that an
organization formed by the unit owners of a condominium housing project to provide for the
management, maintenance, and care of the common areas of the project, as defined by
State statute, with membership assessments paid by the unit owners does not qualify for
exemption under IRC section 501(c)(4).

Form 886-A(Rev.4-68)

Department of the Treasury - Internal Revenue Service

Page: -2-


Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit

Explanation of Items

Name of Taxpayer Year/Period Ended

December 31, 20XX

Initial Examination Report

In Revenue Ruling 74-99,1974-1 CB 131, (Jan. 01,1974), the Service held that a
homeowners association must satisfy the following requirements in order to qualify for
exemption under IRC section 501(c)(4):

(1) must serve a “community” which bears a reasonable recognizable relationship to an
area ordinarily identified as governmental,

(2) it must not conduct activities directed to the exterior maintenance of private
residences, and

(3) the common areas or facilities it owns and maintains must be for the use and
enjoyment of the general public.

In Commissioner v. Lake Forest, Inc., 305 F. 2d 814 (1962), it was held that a corporation
that provided housing on a cooperative basis lacked the necessary requirements of an
organization described in section 501(c)(4) of the Code. The court held the operation to be
a private self-help enterprise with only an incidental benefit to the community as a whole.
The court also held that the organization is operated primarily for the private benefit of
members and any benefits to the community are not sufficient to meet the requirement of
the regulation that the organization be operated primarily for the common good and
general welfare of the people of the community.

Governments Position:

To meet the requirements for exemption under IRC Section 501(c)(4), an organization
must be operated exclusively for the promotion of social welfare and will only be
considered to be operated in this manner, if it primarily engages in promoting in some way
the common good and general welfare of the community Tax Regulation Section
1.501(c)(4)-1(a)(2)(i).

Additionally, for a homeowner's association to qualify for exemption under IRC 501(c)(4),
the common areas or facilities it owns and maintains must be for the use and enjoyment of

Form 886-A (rev.4-68) Department of the Treasury - Internal Revenue Service

Page: -3-

Form 886A

Department of the Treasury - Internal Revenue Service

Explanation of Items

Schedule No. or Exhibit

Name of Taxpayer

Initial Examination Report

Year/Period Ended

December 31, 20XX

the general public Revenue Ruling 74-99. In this specific case, it is clear that your
organization does not meet this requirement because the general public is strictly
prohibited from any use and enjoyment of your common areas.

Based a thorough review of the applicable law and facts and circumstances present in this
case, we determined that your organization’s activities, financial resources, and common
areas are being provided exclusively for the private benefit of your members and not for
the common good and general welfare of the community within the meaning of IRC
501(c)(4).

As a result, your organization is not being operated primarily for the promotion of social
welfare purposes and therefore, fails to meet the requirements for continued exemption as
a social welfare organization described in IRC 501(c)(4).

Conclusions:

We are proposing revocation of your exempt status, as an organization described in IRC
501(c)(4), effective as of January 01, 20XX. You are now required to file Federal income
tax returns on Form 1120 or 1120-H beginning with tax years ended December 31, 20XX
and all subsequent years thereafter.

Form 886-A(Rev.4-68)

Department of the Treasury - Internal Revenue Service

Page: -4-